You can't really fault Cleveland-Cliffs and its operating performance; the company handily beat earnings estimates and raised guidance for 2022 steel prices during the month.
So what was the problem? The market had largely expected good performance, since the company had already risen so much heading into April. With surging inflation and fears of an economic downturn next year, Cleveland-Cliffs wound up falling along with most other cyclical stocks.
In its first-quarter results, Cleveland-Cliffs delivered 50% revenue growth to $6 billion, and adjusted (non-GAAP) earnings per share of $1.71.
Not only did these booming results blow away estimates, but management also raised its outlook for steel prices for the rest of 2022 relative to its fourth-quarter guidance. That's not a surprise, since the Russian invasion of Ukraine happened in between, and Russia is a big importer of pig iron feedstock to U.S. steelmakers.
So... what exactly was the problem? Well, the entire market had a terrible month, with the S&P 500 index down 8.8%. Rising inflation and uncertainty about the path of interest rates caused many to anticipate a recession next year. Usually, materials stocks such as steelmakers don't do well in a recession. With Cleveland-Cliffs already up nearly 50% on the year heading into April, investors decided to take profits, perhaps feeling the stock was at the "top" of the cycle.
It's kind of interesting that Cleveland-Cliffs sold off even as other cyclical trades such as energy stocks have gone higher. Meanwhile, after its decline, Cleveland-Cliffs only trades around four times this year's earnings estimates. That's pretty cheap!
Obviously, the market is anticipating a downturn, though Cleveland-Cliffs does have another $5 billion-plus of debt and another $4 billion of pension liabilities on its balance sheet. Therefore, when factoring those in, Cleveland-Cliffs' enterprise value is about 68% higher than its market cap. That would raise its enterprise value-to-earnings ratio to 6.8, which is still pretty cheap.
As with all cyclical stocks, the price of steel is determined through a delicate balance of supply and demand, as well as import and export tariff restrictions. So the future is definitely cloudy.
Still, if I had to bet, I would lean toward Cleveland-Cliffs being undervalued. Russian feedstock and other foreign-made inputs will likely be restricted going forward, and President Biden just administered guidance that the Infrastructure Investment and Jobs Act requires American-made iron ore and steel. Automobile demand is also strong today, even if not what it was last year. All in all, steel prices could remain higher for longer amid de-globalization.
That being said, if we have a severe recession, that would hurt demand. Therefore, investing in Cleveland-Cliffs depends on what you believe in terms of these large macroeconomic and geopolitical factors.